Rising China Has Limited Influence

Every generation carries with it the conceit sometimes warranted – that they are entering a period of immense change and living through a period of historic significance.

This conviction is behind Prime Minister Julia Gillard commissioning a white paper on Australia in the Asian century. As the first line in the terms of reference for the white paper states, “The greatest influence on the future prosperity of Australia is the dramatic shift of economic power and, as a result, strategic weight to Asia.”

Fair enough. But the trick is to remember that identifying areas of economic and strategic continuity is as important as detecting irresistible shifts and transformation.

Although Gillard’s September speech introducing the white paper correctly included Japan, India and Indonesia as the region’s current and rising giants of note, most attention will be focused on China, and with good reason. China’s rise has been the most rapid and dramatic over the past three decades. It is now the largest economy in Asia and the second-largest in the world. For the first time in our history, our largest trading partner is no longer a member of the Western alliance and is in fact emerging as a strategic competitor to the US.

One common concern is that China’s economic size and importance will naturally exert irresistible pressure on regional states to move closer to Beijing’s strategic orbit. But the evidence overwhelmingly points to a contrary phenomena. Every major capital in Asia has moved closer to Washington (and each other) while growing ever more suspicious of Beijing’s future intentions even as trade with China deepens.

This includes Japan, South Korea, Thailand, The Philippines, Malaysia, Singapore, India, Indonesia, Vietnam and Australia. Indeed, almost all regional states are busily ensuring that the US remains the pre-eminent strategic actor in the region. Were Australia to consider a different path, it would be the outlier in the region.

The interesting question is why such an economically large China is failing to exert significant strategic pull or pressure on regional states. It comes down to China’s surprising incapacity in translating economic size into leverage. This is where China’s GDP and its impressive trade numbers are misleading. China is the largest trading partner of Japan, South Korea, India and Australia. In theory, trade can be used as a carrot or a stick to bring neighbouring countries into its orbit. The problem for Chinese leverage is that at least half, and perhaps as much as two-thirds, of its trade with East and Southeast Asia is “processing trade”, with two-thirds of all finished products going to the US and Europe.

The Western consumer is, and will remain, far more important for regional economies than Asian consumers. The combined size of the US and EU consumer market is about $US20 trillion ($20.1 trillion), compared to about $US2.3 trillion for China and India collectively.

Even assuming the continuation of rapid growth in the developing giants and anaemic growth in the industrialised economies over the next decade, we are still looking at a consumption market of $US25 trillion versus one of $US5 trillion respectively.

Back to current reality, China could try to get its way by imposing selective trading bans on major firms or even countries. But if it did, production chains would be disrupted at great cost to all parties, including China. Asian firms would eventually find other manufacturing avenues. Besides, China needs the technology transfer that comes with this trade, and politically can’t afford to damage its export manufacturing sector, which employs 150-200 million workers.

Until China becomes the dominant centre for domestic consumption in the region and becomes the end consumer of manufactured goods, its impact as a driver of growth will be concentrated in the commodity markets. Even then, China will need Australian resources as much as we need to sell these to the Chinese.

The other way China might use trade as a weapon would be to selectively grant or withdraw market access to foreign firms and governments. The problem for Beijing is that the Chinese economy currently constitutes a large component of global economic growth, but is not so important a driver of that growth. This is due to the fact that 50-60 per cent of GDP growth is driven by domestically funded fixed investment.

China’s total domestically funded fixed investment amounts to about $US2.5 trillion each year, as compared to $US105 billion of foreign direct investment, which is mainly destined for the export manufacturing sector. More than three-quarters of all bank loans go to state-owned enterprises, and the most important and lucrative sectors are reserved for SOEs. This means few foreign firms actually enjoy access to the most profitable Chinese markets.

Policies protecting SOEs are likely to remain since this is at the heart of how the Communist Party retains economic influence and relevance in the country. But it will further restrict Beijing’s ability to use access to markets as a point of leverage. A white paper on Australia in the Asian century might prove valuable, but only if the review takes these current and future realities into account.